Docstoc

EFRAG DCL FASB ED Financial Instruments

Document Sample
EFRAG DCL FASB ED Financial Instruments Powered By Docstoc
					DRAFT COMMENT LETTER

 Comments should be submitted by 13 September 2010 to Commentletters@efrag.org
In particular, EFRAG would be grateful to receive answers to the question it raises
in paragraph 82 of Appendix 1 to this Draft Comment Letter.



XX Month 2010


Financial Accounting Standards Board
Attn. Technical Director, File Reference No. 1810-100,
401 Merritt 7
PO Box 5116
Norwalk
CT 06856-5116
USA

cc.: International Accounting Standards Board
     30 Cannon Street
     London EC4M 6XH
     United Kingdom



Dear Sir / Madam

Re: Exposure Draft, Accounting for Financial Instruments and Revisions to the
Accounting for Derivative Instruments and Hedging Activities

On behalf of the European Financial Reporting Advisory Group (EFRAG), I am writing to
comment on the FASB’s Exposure Draft Accounting for Financial Instruments and
Revisions to the Accounting for Derivative Instruments and Hedging Activities (‘the
FASB Exposure Draft’) that was published on 26 May 2010.

EFRAG is a private sector body established to provide input into the development of
IFRSs issued by the International Accounting Standards Board (IASB) and to provide
the European Commission with technical expertise and advice on the technical quality of
IFRSs.

EFRAG is commenting on the proposals in the FASB Exposure Draft, both in response
to a request made by the IASB on 27 May 2010 and with a view to contributing to the
development of high-quality accounting standards for financial instruments, suitable for
use in global capital markets. As such, this letter does not necessarily reflect the
conclusions that EFRAG would reach in its capacity as adviser to the European
Commission on endorsement of IFRSs for use in Europe.

As part of the response to the recent financial crisis, the Group of Twenty (G-20) called
on accounting standard setters to work urgently to achieve a single set of high-quality
global accounting standards. Consequently, the FASB and the IASB jointly affirmed
their commitment to achieve convergence of IFRSs and US GAAP and we understand
that the FASB Exposure Draft forms part of the global convergence project of the IASB
and the FASB. Nevertheless, the FASB Exposure Draft marks a significantly different
         FASB Exposure Draft on Financial Instruments – Draft Comment Letter


approach to financial instruments accounting than that taken by the IASB1 and EFRAG
is concerned about the difficulties the two Boards may face in reconciling differing views
on this project.

Whilst we recognise the commitment on convergence made by the IASB and FASB to
the G-20, we believe that this commitment should not be met at the expense of quality.
In our view, a ‘high-quality’ accounting standard on financial instruments for world-wide
use must be capable of reflecting the range of business models that exists globally.
Therefore, EFRAG does not support the proposals in the FASB Exposure Draft as it
believes that they do not give appropriate emphasis to the business model; nor are the
proposals capable of reflecting the range of business models that exist.

In this letter, EFRAG formulates its recommendations to both the FASB and IASB on
how to meet best the objective of achieving a single high-quality standard on financial
instruments. Our views are presented in detail in Appendix 1 to this letter and
summarised below.

In our view, the FASB proposals do not provide a basis for a high-quality standard on
accounting for financial instruments. We are supportive of the broad direction set by the
IASB in its project to replace IAS 39 Financial Instruments: Recognition and
Measurement. Therefore, we believe that the directions set by the IASB should form the             Formatted: Font: Not Italic
basis for the development of a converged standard. As a result, convergence should
only be achieved on the basis of the broad direction set by the IASB in its project to
replace IAS 39 Financial Instruments: Recognition and Measurement. We support,
more specifically, the following elements in the IASB’s approach:

     classification criteria based on the characteristics of the financial instruments and
        the business model used by the entity in managing those financial instruments;
     a mixed measurement model that allows for financial instruments to be reported at
        either amortised cost or fair value, depending on the business model;
     reclassification required when there is a change in the conditions that lead to initial
        classification;
     primary financial statements that reflect one measurement attribute only;
     impairment of financial assets measured at amortised cost based on an expected
        loss approach that uses all available credit-related information, including
        forecasts of future events and future economic conditions; and
     changes in fair value of a financial liability attributable to an entity’s own credit risk
        impacting profit or loss, when such liabilities are measured at fair value for the
        sole purpose of reducing accounting mismatches.

However, we consider that both Boards should work together to develop a standard in
the direction set by the IASB. In our view, a high-quality standard on financial
instruments starts from the principles in IFRS 9 Financial Instruments (IFRS 9) and
incorporates the following:

     greater emphasis on the business model whilst remaining faithful to a need to
        consider the characteristics of the financial instrument;




1
 IFRS 9 Financial Instruments and IASB Exposure Drafts on Financial Instruments: Amortised
Cost and Impairment and the Fair Value Option for Financial Liabilities.


                                            Page 2
         FASB Exposure Draft on Financial Instruments – Draft Comment Letter


     separate accounting for embedded derivatives for both hybrid financial assets and
        hybrid financial liabilities;
     recognition in profit or loss of realised gains and losses on equity instruments
        measured at fair value when unrealised changes are recognised in other
        comprehensive income; and
     consistent measurement of financial assets and financial liabilities when they are
        linked together.

Finally, the Boards have proposed to allow financial instruments to be measured at fair
value through other comprehensive income, albeit in different circumstances and for
different instruments. In this context, EFRAG considers that IASB and FASB should
work together to better define the use and purpose of other comprehensive income.

Summary of EFRAG Recommendations: IASB Directions

Classification criteria

EFRAG supports classification criteria that differentiate between financial instruments
measured at amortised cost and financial instruments measured at fair value based on
the characteristics of the financial instruments and the business model adopted by the
entity in managing those financial instruments.

We disagree with the multiple measurement options presented in the FASB Exposure
Draft (i.e. fair value through other comprehensive income for debt instruments carried for
collection or payment of contractual cash flows, amortised cost option for eligible short-
term receivables and amortised cost for liabilities creating an accounting mismatch). We
believe instead that to increase comparability and reduce complexity, the choice of
measurement attribute follows directly from the characteristics of the financial instrument
and the business model used by the entity in managing the financial instrument.

Mixed measurement model

EFRAG strongly believes that financial instruments accounting should be based on a
mixed measurement model. In our view, debt instruments that are held for the collection
or payment of contractual cash flows are more appropriately measured at amortised
cost, since this measurement attribute best represents the potential future cash flows
that the entity will achieve. Therefore, giving prominence in the statement of financial
position to the fair value measurement, of such debt instruments, as proposed by the
FASB, could be misleading, as it would reflect gains that might be never realised and
losses that are not expected to occur. In addition, the recent debates on measurement
at fair value of financial liabilities and the effects of changes in the entity’s own credit risk
have highlighted that fair value measurement is not necessarily suited to financial
liabilities.

Reclassification

As proposed by the IASB, reclassification should be required for financial instruments
when current circumstances indicate that the business model for the instrument has
changed; should reclassification not be required, the use of an inappropriate
measurement attribute could undermine the relevance of the resulting financial
reporting.

Primary financial statements reflecting one measurement attribute only


                                            Page 3
        FASB Exposure Draft on Financial Instruments – Draft Comment Letter


For each financial instrument, only one measurement attribute should be reflected in the
primary financial statements. The choice of measurement attribute follows directly from
the characteristics of the financial instrument and the business model used by the entity
in managing the financial instrument. Amortised cost is the measurement attribute that
best represents the business model for debt financial instruments held for collection or
payment of contractual cash flows. Presenting the fair value for such financial assets
and liabilities implicitly assumes an exit value and such information is not useful in
assessing the financial performance of an entity that does not intend to exit or liquidate
its core business.

In addition, the presentation of two measurement attributes on the face of the statement
of financial position, as proposed by the FASB for certain debt instruments, may result in
additional complexity and over-detailed primary statements. This could obscure key
messages and complicate, rather than improve, the communication between preparers
and users of financial statements. Where amortised cost is deemed relevant for primary
financial statements, the measurement at fair value may play the role of providing
supplementary information but such information can be presented much more clearly in
the notes to the financial statements than on the face of the primary statements.

Expected loss approach for impairment

The amortised cost and impairment model for financial assets should be based on an
expected loss approach founded on the conceptual principles proposed by the IASB. An
entity’s estimate of impairment losses should reflect all existing information including
expected future developments and forecasts of future events and economic conditions.
This would ensure that management estimates reflect, on a timely basis, appropriate
forward-looking information and that a greater range of information about the credit
quality of financial assets is incorporated in reported measurement.

We consider that requiring an entity to isolate credit information that relates to past and
existing trends from that which relates to forecasts of future developments adds
complexity and judgement to the estimation process and could result in reduced
comparability.

We agree with the IASB’s proposal that credit losses expected at initial recognition
should be allocated over the life of the financial asset. As a result, net interest revenue
reflects that some of that interest is paid in compensation for credit losses expected on
initial recognition. Gains and losses resulting from changes in estimates of future cash
flows should be recognised in the period of the re-estimate, to the extent that the change
relates to current or prior periods.

Finally, given the importance of the interest margin in financial analysis by users, we
believe that separate recognition of effective interest components (i.e. fees, points
received, transaction costs and other premiums and discounts), credit loss expectations
and other fair value adjustments provides more decision-useful information than a net
presentation of these amounts.

Own credit risk

When fair value accounting for financial liabilities is elected in order to reduce
accounting mismatches, fair value changes due to changes in an entity’s own credit risk
should not affect profit or loss. This would address long-standing concerns that it is




                                         Page 4
         FASB Exposure Draft on Financial Instruments – Draft Comment Letter


misleading to report the effects of changes in own credit risk of liabilities not held-for-
trading purposes in profit or loss.


Summary of EFRAG Recommendations: Suggested improvements for the
formulation of the final standard

Greater emphasis on the business model

In developing a single, high-quality accounting standard for financial instruments, the
boundaries between amortised cost and fair value measurement should more closely
reflect the business model. However, we acknowledge that the characteristics of the
instrument must also be considered.

In addition, in the assessment of credit risk losses for financial assets, consideration
should be given to the amortised cost measurement resulting from the application of a
forward-looking approach to expected losses. This approach would allow an entity to
reflect properly credit risk in the adjustments to expected cash flows without introducing
additional variables such as liquidity premiums and other adjustments.

Separate accounting for embedded derivatives

We encourage the development of a simplified and principles-based identification of
embedded derivatives to be separately accounted for at fair value though profit or loss.
The same principle should be applied to bifurcation of embedded derivatives for both
hybrid financial assets and hybrid financial liabilities.

Investments in equity instruments

We believe that equity investments not held-for-trading should be accounted for
differently from equity investments held-for-trading and measured at fair value through
profit or loss. Specifically, equity investments not held-for-trading should be measured
at fair value with changes in fair value recognised in other comprehensive income,
subject to an impairment test. Reclassification to profit or loss upon realisation of gains
and losses resulting from subsequent measurement should be maintained, until an in-
depth debate has taken place on: (i) performance reporting, (ii) the use of other
comprehensive income and (iii) reclassification from other comprehensive income to
profit or loss.

Consistent measurement of financial assets and liabilities that are linked together

We recognise that a mixed measurement model can result in accounting mismatches.
EFRAG believes that requiring the measurement of all financial instruments at fair value
is not the best solution to address accounting mismatches. A mixed measurement
model should be combined with an option that allows for a consistent measurement
basis for financial assets and financial liabilities that better reflects the links existing
between those assets and liabilities.

Other matters

Equity method of accounting for investments in associates




                                          Page 5
        FASB Exposure Draft on Financial Instruments – Draft Comment Letter


EFRAG disagrees with the change to the criteria for the use of the equity method of
accounting that the FASB proposes and believes that the debate on accounting for
financial instruments should not encompass changes to the accounting standards
applicable to investments in associates.

Core deposits

EFRAG strongly disagrees with the proposed re-measurement approach for core
deposits in the FASB Exposure Draft. We do not consider that the use of a hypothetical
measure based on alternative funding costs provides relevant information about the
actual benefit provided by a core deposit base. We also consider that it is inappropriate
to consider the accounting treatment of core deposit intangibles separately from other
similar intangibles.



If you wish to discuss our comments further, please do not hesitate to contact
Chiara Del Prete or me.



Yours sincerely



Françoise Flores
EFRAG, Chairman




                                         Page 6
           FASB Exposure Draft on Financial Instruments – Draft Comment Letter



APPENDIX 1



SCOPE

Questions for all respondents
Question 2
The proposed guidance would require loan commitments, other than loan commitments
related to a revolving line of credit issued under a credit card arrangement, to be
measured at fair value. Do you agree that loan commitments related to a revolving line
of credit issued under a credit card arrangement should be excluded from the scope of
this proposed Update? If not, why?

Notes for EFRAG’s constituents

1       The FASB Exposure Draft proposes loan commitments to be measured at fair
        value, except for loan commitments related to a revolving line of credit issued
        under a credit card arrangement, which are required to be measured according to
        Subtopic 310-20 ‘Non-refundable fees and other costs’2. As presented in
        Appendix B to the FASB Exposure Draft3, for loan commitments in the scope of
        the proposals, potential lenders classify loan commitments in the same manner as
        the loan once funded was classified. If a loan measured at fair value with changes
        in fair value recognised in other comprehensive income is funded, accounting for
        the commitment fee would be a yield adjustment of the related loan. Potential
        borrowers and issuers of lines of credit issued as part of credit card arrangements
        would be excluded from the scope.

2       As explained in paragraph BC134 of the Exposure Draft, the Board considered
        implementation issues that could be encountered by issuers in measuring certain
        types of loan commitments at fair value. In particular, for practical reasons the
        scope exception was provided for lines of credit under credit card arrangements,
        considering the generally small balances of the associated credit card receivables,
        the revolving nature of these lines of credit, and the high volume of these lines of
        credit and related receivables. Therefore, credit card fees would continue to be
        accounted for under Subtopic 310-20.

3       Under IFRS, only some loan commitments are within the scope of IFRS 9 and IAS
        39 (i.e., loan commitments that the entity designates as financial liabilities at fair
        value through profit or loss; loan commitments in presence of a past practice of
        selling the assets resulting from loan commitments shortly after the origination;
        loan commitments that can be settled net in cash or by delivering or issuing
        another financial instrument). For commitments within the scope, subsequent
        measurement would depend on the terms of the instrument and the entity’s




2
    Paragraph IG85 of the FASB Exposure Draft.
3
    IG 81-86 of the FASB Exposure Draft.


                                            Page 7
        FASB Exposure Draft on Financial Instruments – Draft Comment Letter


     circumstances; for commitments outside the scope, provisions in IAS 37 shall be
     applied.

Response to Question 2

4    EFRAG agrees that where necessary operational concerns can justify the
     adoption of simplified accounting requirements.       However, such simplified
     accounting treatment should be applicable to all financial instruments having the
     same economic substance, rather than for specific contractual types.

5    Therefore, EFRAG questions why the scope exemption is limited to certain credit
     card commitments and suggests it should apply to all loan commitments with
     similar features. Furthermore, EFRAG believes that accounting treatment of the
     loan commitment should be independent from the classification and measurement
     of the loan when drawn.


Question 3
The proposed guidance would require deposit-type and investment contracts of
insurance and other entities to be measured at fair value. Do you agree that deposit-
type and investment contracts should be included in the scope? If not, why?

Notes for EFRAG’s constituents

6    Paragraph BC39 of the FASB Exposure Draft explains that investments in life
     insurance contracts should be excluded from the scope of the proposed guidance
     because the contracts have an insurance element; such contracts generally are
     purchased for funding purposes, for example, to fund deferred compensation
     agreements or postemployment death benefits, and the entity purchasing life
     insurance is either the owner or beneficiary of the contract. The FASB determined
     that it would be inappropriate to address policyholder accounting as part of this
     project.

7    According to paragraph BC40 of Exposure Draft, the FASB believes that life
     settlement contracts do not have a direct insurance element. These contracts do
     not involve an insurable interest, and the investor is not a policyholder. Therefore,
     the Board decided that life settlement contracts should be included in the scope of
     the proposed guidance.

8    IFRS 4 defines an insurance contract as “A contract under which one party (the
     insurer) accepts significant insurance risk from another party (the policyholder) by
     agreeing to compensate the policyholder if a specified uncertain future event (the
     insured event) adversely affects the policyholder.”

Response to Question 3

9    This response does not address the measurement of insurance contracts, which is
     not part of this FASB Exposure Draft. These proposals pre-empt any proposal
     from the Boards’ joint project on insurance contracts. We therefore urge both
     Boards to consider the inclusion of insurance contracts within a financial
     instruments standard as part of the project on insurance contracts.



                                        Page 8
        FASB Exposure Draft on Financial Instruments – Draft Comment Letter


10   However, subject to future decisions in insurance, in particular on unbundling of
     insurance contracts, EFRAG believes that contracts that involve a significant
     insurance risk should be accounted for as insurance contracts, regardless of the
     industry sector of the reporting entity. EFRAG agrees that deposit-type and
     investment contracts that do not have significant insurance risk and that otherwise
     meet the definition of a financial instrument should be included within the scope of
     the standard on financial instruments.


Question 4
The proposed guidance would require an entity to not only determine if they have
significant influence over the investee as described currently in Topic 323 on accounting
for equity method investments and joint ventures but also to determine if the operations
of the investee are related to the entity’s consolidated business to qualify for the equity
method of accounting. Do you agree with this proposed change to the criteria for equity
method of accounting? If not, why?

Notes for EFRAG’s constituents

11   The FASB Exposure Draft is proposing to change the criteria for use of the equity
     method of accounting. As a result of the proposed change, in order to qualify for
     the application of the equity method, two conditions need to be met: (i) the investor
     needs to have significant influence over the investee and (ii) the operations of the
     investee need to be considered related to the investor’s consolidated operations.

12   If only one of the two criteria is met, the investor shall account for the investment in
     the equity security at fair value with all changes in fair value recognised in profit or
     loss.

13   The FASB Exposure Draft presents factors to be considered in determining
     whether the activities of an investee are related to an entity’s consolidated
     operations. These factors include the line of business in which they both operate,
     the level of transactions between the investee and the entity, and the extent to
     which management are common to both parties.

14   In addition, the FASB Exposure Draft is proposing to eliminate the option to
     measure at fair value investments in equity securities that qualify for the equity
     method of accounting. The application of the equity method would be a
     requirement if the two conditions described in the paragraph above are met and
     fair value option would be precluded.

Response to Question 4

15   EFRAG disagrees with the change to the criteria for the use of the equity method
     of accounting that is being proposed by the FASB.

16   EFRAG believes that the debate on accounting for financial instruments should not
     encompass changes to the accounting for investments in associates.

17   Finally, EFRAG is not aware that a need to change the accounting for investments
     in associates exists.



                                          Page 9
        FASB Exposure Draft on Financial Instruments – Draft Comment Letter




INITIAL MEASUREMENT

Questions for all respondents
Question 8
Do you agree with the initial measurement principles for financial instruments? If not,
why?

Question 9
For financial instruments for which qualifying changes in fair value are recognized in
other comprehensive income, do you agree that a significant difference between the
transaction price and the fair value on the transaction date should be recognized in net
income if the significant difference relates to something other than fees or costs or
because the market in which the transaction occurs is different from the market in which
the reporting entity would transact? If not, why?

Question 10
Do you believe that there should be a single initial measurement principle regardless of
whether changes in fair value of a financial instrument are recognized in net income or
other comprehensive income? If yes, should that principle require initial measurement
at the transaction price or fair value? Why?

Question 11
Do you agree that transaction fees and costs should be (1) expensed immediately for
financial instruments measured at fair value with all changes in fair value recognized in
net income and (2) deferred and amortized as an adjustment of the yield for financial
instruments measured at fair value with qualifying changes in fair value recognized in
other comprehensive income? If not, why?

Notes for EFRAG’s constituents

18   The response below addresses Questions 8, 9, 10 and 11.

19   The FASB Exposure Draft4 requires financial instruments to be initially recognised
     at fair value if all subsequent changes in their fair value will be recognised in profit
     or loss. Those financial instruments with a qualifying portion of subsequent
     changes in fair value to be recognised in other comprehensive income (i.e.,
     financial instrument for which the entity’s business strategy is to hold for collection
     or payment of contractual cash flows) are initially measured at transaction price.

20   For financial    instruments measured at fair value with changes in fair value
     recognised in     profit or loss, transaction fees and costs would be recognised in
     profit or loss    as expenses upon initial recognition. For financial instruments
     measured at        fair value with changes in fair value recognised in other



4
 The proposed guidance is addressed in paragraphs 12-17, IG7-IG9 and BC46-BC48 of the
FASB Exposure Draft.


                                         Page 10
           FASB Exposure Draft on Financial Instruments – Draft Comment Letter


     comprehensive income, transaction fees and costs would be deferred and
     recognised in profit or loss as a yield adjustment of the related financial instrument
     over the life of the instrument. These proposals are broadly similar to IFRS
     existing requirements. A financial asset (liability) is measured initially at its fair
     value plus (minus), in case of a financial asset (liability) not at fair value through
     profit or loss, transaction costs that are directly attributable to the acquisition of the
     financial asset (liability) (IFRS 9 paragraph 5.1.1 and IAS 39 paragraph 43).

21   For financial instruments recognised at transaction price, if reliable evidence
     indicates that the transaction price differs significantly from the fair value, and the
     entity determines that the difference is at least partially due to the existence of
     elements (other than transaction fees and costs or because the market in which
     the transaction occurs is different from the market in which the reporting entity
     would transact) the entity shall initially measure the financial instrument at its fair
     value and shall account for any other element or elements in the transaction in
     accordance with their nature, recognising any asset or liability. If the entity cannot
     reasonably identify the other element involved in a transaction, the entity should
     recognise a Day 1 gain or loss in profit or loss.

22   Recognition of Day 1 profits is generally only possible under IFRS in respect of
     financial instruments that are measured using observable inputs.            The
     requirements of paragraphs AG76 and AG76A of IAS 39, in effect, prohibit the
     recognition of Day 1 gains in respect of other financial instruments.

Response to Questions 8, 9, 10 and 11

23   EFRAG believes that:

     (a)     a financial asset (liability) should be initially measured at its fair value plus
             (minus), in case of a financial asset (liability) not at fair value through profit or
             loss, transaction costs that are directly attributable to the acquisition of the
             financial asset (liability);

     (b)     putting aside transaction costs, fair value will generally equal the transaction
             price. If at initial recognition of a financial instrument a difference between
             fair value and transaction price exists, the entity should recognise the
             difference between the transaction price and the fair value as a gain or loss
             only if that fair value is evidenced by observable market prices or, when
             using a valuation technique, by observable market data.




                                            Page 11
        FASB Exposure Draft on Financial Instruments – Draft Comment Letter


SUBSEQUENT MEASUREMENT

Questions for all respondents
Question 13
The Board believes that both fair value information and amortized cost information
should be provided for financial instruments an entity intends to hold for collection or
payment(s) of contractual cash flows. Most Board members believe that this information
should be provided in the totals on the face of the financial statements with changes in
fair value recognized in reported stockholders’ equity as a net increase (decrease) in net
assets. Some Board members believe fair value should be presented parenthetically in
the statement of financial position. The basis for conclusions and the alternative views
describe the reasons for those views. Do you believe the default measurement attribute
for financial instruments should be fair value? If not, why? Do you believe that certain
financial instruments should be measured using a different measurement attribute? If
so, why?

Question 15
Do you believe that the subsequent measurement principles should be the same for
financial assets and financial liabilities? If not, why?

Question 23
The proposed guidance would establish fair value with all changes in fair value
recognized in net income as the default classification and measurement category for
financial instruments. An entity can choose to measure any financial instrument within
the scope of this proposed Update at fair value with all changes in fair value recognized
in net income, except for core deposit liabilities which must be valued using a re-
measurement approach. Do you believe that a default classification and measurement
category should be provided for financial instruments that would otherwise meet the
criteria for qualifying changes to be recognized in other comprehensive income? If not,
why?

Notes for EFRAG’s constituents

24   The response below addresses questions 13, 15 and 23.

25   As explained by the FASB in the Summary of the Exposure Draft, in the FASB’s
     view

           “...a consistent measurement model for all financial instruments should
           improve both comparability across entities and consistency in how an entity
           accounts for different financial instruments. Many have said that there
           should be symmetry between the accounting for financial assets and the
           financial liabilities funding those assets. This may be particularly relevant for
           financial institutions as financial liabilities are incurred in order to support
           related financial asset activity. Asset-liability management is core to the
           business strategy and analysis of financial institutions. Changes in market
           variables affect valuations of both financial assets and financial liabilities.
           Accordingly, like financial assets in the proposed model, many financial
           liabilities of financial institutions would be measured at fair value (with
           amortised cost also being presented for certain financial liabilities)”.



                                         Page 12
        FASB Exposure Draft on Financial Instruments – Draft Comment Letter


26   In addition, in paragraph BC8, FASB observes that

           “although accounting requirements were not the cause of the recent global
           financial crisis, the crisis highlighted particular issues with the present mixed-
           attribute measurement model for financial instruments. In brief, the present
           mixed-attribute measurement model sometimes provides inadequate
           information that an entity and its advisors and investors need to effectively
           assess risk. The present model relies too heavily on subjective classification
           of financial instruments that determines either or both their measurement
           attribute and how the resulting gains or losses are recognized”.

27   In the Comment Letter to the FASB Exposure Draft Financial Instruments:
     Classification and Measurement, EFRAG expressed a preference for the mixed
     measurement model. In particular, the “IASB considered the possibility of
     introducing a single measurement category for all financial assets and financial
     liabilities but concluded, as paragraph BC13 explains, that measuring all financial
     assets and financial liabilities at fair value is not the most appropriate approach to
     improve the financial reporting for financial instruments. It is therefore proposing
     that a mixed measurement model be retained. We agree with this decision and
     reasoning.”

28   In addition, in the Comment Letter to the Discussion Paper Reducing Complexity
     in Reporting Financial Instruments, EFRAG expressed the following view: “we
     think it is premature, and perhaps even inappropriate, to decide under current
     circumstances that the only appropriate measure for financial instruments is fair
     value and that any changes to IAS 39 should represent a step towards that
     objective.”

Response to Questions 13, 15 and 23

29   EFRAG strongly supports the adoption of classification criteria that differentiate
     between financial instruments measured at amortised cost and financial
     instruments measured at fair value, based on the business model adopted by the
     entity in managing financial instruments, along with an assessment of the
     characteristics of the financial instrument itself.

30   The business model and characteristics of the instrument tests should drive
     classification of both financial assets and financial liabilities.

31   A mixed measurement model based on the business model allows for a faithfully
     representation of different business models. For a traditional bank, measurement
     at amortised cost of financial assets and liabilities classified mainly in the banking
     book would better reflect how financial instruments contribute to the entity’s net
     results and financial position (i.e. based on their contractual cash flows).
     However, for an investment bank, measurement at fair value of financial assets
     and liabilities that are mainly classified in the held-for-trading category would better
     reflect their contribution to the entity’s result and financial position.

32   We understand from users that amortised cost provides more decision-useful
     information than fair value for assets and liabilities held for collection or payment of
     contractual cash flows.




                                         Page 13
        FASB Exposure Draft on Financial Instruments – Draft Comment Letter


33   We strongly disagree with the approach proposed by the FASB, which requires
     measurement at fair value in the statement of financial position of financial assets
     that the entity manages on a contractual yield basis and that are not held for sale
     in the short term. Reporting of financial assets and liabilities at fair value, implicitly
     assumes an exit or ‘liquidation’. Such information is not useful in assessing the
     financial performance of an entity that does not intend to exit or liquidate its core
     business.

34   EFRAG believes that requiring measurement of all financial instruments at fair
     value is not necessarily the best solution to reducing accounting mismatches.
     Measuring all financial assets and liabilities at fair value would not reduce
     accounting mismatches resulting from non-financial items accounted on a cost
     basis. Measuring all financial assets and liabilities at fair value would not reduce
     accounting mismatches due to financial assets and liabilities having different
     maturities.

35   In our view, a mixed measurement model should be combined with an option that
     allows for consistent measurement and recognition for financial assets and
     financial liabilities, in order to best reflect the links existing between those assets
     and liabilities.

36   In addition, EFRAG is doubtful about the proposal for measuring all financial
     liabilities at fair value. In fact, recent debates on measurement at fair value of
     financial liabilities and on the effects of changes in an entity’s own credit risk have
     highlighted that fair value measurement is not necessarily suited for financial
     liabilities that are neither derivatives nor held-for-trading, unless it would reduce
     eventual accounting mismatches.

37   In conclusion, we believe that the IASB’s mixed measurement model clearly leads
     to better, more decision-useful, financial reporting than the FASB proposals.


Question 14
The proposed guidance would require that interest income or expense, credit
impairments and reversals (for financial assets), and realized gains and losses be
recognized in net income for financial instruments that meet the criteria for qualifying
changes in fair value to be recognized in other comprehensive income. Do you believe
that any other fair value changes should be recognized in net income for these financial
instruments? If yes, which changes in fair value should be separately recognized in net
income? Why?

Question 22
Do you believe that the recognition of qualifying changes in fair value in other
comprehensive income (measuring the effects of subsequent changes in interest rates
on fair value as well as reflecting differences between management’s and the market’s
expectations about credit impairments) will provide decision-useful information for
financial instruments an entity intends to hold for collection or payment(s) of contractual
cash flows? If yes, how will the information provided influence your analysis of an
entity? If not, why?




                                          Page 14
        FASB Exposure Draft on Financial Instruments – Draft Comment Letter


Notes for EFRAG’s constituents

38   The response below addresses questions 14 and 22

39   The FASB Exposure Draft requires financial instruments that an entity, under its
     business strategy, holds for collection or payment(s) of contractual cash flows to
     be measured at fair value in its Statement of Financial Position, with changes in
     fair value in each period recognised in other comprehensive income. The FASB
     explains that in this way profit or loss will continue to reflect business strategy,
     since only changes arising from interest accruals, credit impairments, and realised
     gains and losses would be recognised in profit or loss each reporting period, while
     all other changes in fair value from these instruments would be recognised in other
     comprehensive income.

40   In paragraph BC100 of the FASB Exposure Draft, the FASB states that:

          “The Board believes that recognizing qualifying changes in fair value for
          financial instruments for which an entity’s business strategy is to hold for
          collection or payment of contractual cash flows in other comprehensive
          income also would enable entities to preserve most of the traditional concept
          of net income (including net interest margin) and earnings per share. Also,
          the Board believes that (a) information about the realization of cash flows is
          important for financial instruments an entity intends to hold for collection or
          payment(s) of contractual cash flows and (b) amortized cost would provide
          information on current-period cash flow realizations in net income. The
          Board believes that the portion of the change in fair value that is recognized
          in other comprehensive income would provide additional information by
          indicating either (a) the gains or losses that may be realized if the financial
          instruments cannot be held to collection or payment(s) of contractual cash
          flows or (b) the amount of opportunity gain or loss if the financial instruments
          are held to collection or payment(s) of contractual cash flows. The fair value
          also would provide users with the best available information of the market’s
          assessment of an entity’s expectation of its future net cash flows, discounted
          to reflect both current interest rates and the market’s assessment of the risk
          that the cash flows will not occur.”

41   In paragraph BC58 of the Exposure Draft, the FASB states that:

          “... Also, the Board believes that fair value information would now likely be
          available at the time of earnings releases rather than only being disclosed
          later in the notes to the financial statements for public entities. ...”

Response to Questions 14 and 22

42   EFRAG believes that, to represent fairly the way an entity operates and how it is
     affected by risks, financial instruments that have certain debt characteristics and
     that are held for collection or payment of contractual cash flows should be
     measured at amortised cost. Amortised cost best represents the future cash flows
     that the entity will achieve from holding these instruments. In EFRAG’s opinion, it
     is unhelpful to give undue prominence in the statement of financial position to the
     fair value of such instruments, as such measurement would reflect gains that
     might never be realised and losses that are not expected to occur.




                                       Page 15
         FASB Exposure Draft on Financial Instruments – Draft Comment Letter


43    Fair value information for financial instruments held for collection or payment of
      contractual cash flows can be useful in several circumstances, but it seems
      obvious that such information can be presented much more clearly in the notes to
      the financial statements than on the face of the primary statements.

44    In addition, many debt instruments held for the collection or payment of contractual
      cash flows (such as loans and receivables due from customers) are not
      marketable and their fair value is the result of a subjective measurement based on
      non-observable variables.

45    We observe that during the recent financial crisis users of financial statements
      called for enhanced disclosures on asset quality and credit risk, rather than for the
      increased use of fair value measurement.

46    The proposal to recognise in other comprehensive income (OCI) the fair value
      changes of financial instruments held for collection or payment of contractual cash
      flows would introduce volatility in equity that does not represent results of the
      business model adopted by the entity for the financial instrument in question.
      Therefore, it does not provide decision-useful information on an entity’s
      performance. EFRAG remains to be convinced of the advantages of measuring
      financial instruments at fair value in the statement of financial position and
      retaining traditional concept of performance in profit or loss, while reporting a
      ’residual’ in OCI. Before extending the use of OCI to financial instruments held for
      collection or payment of contractual cash flows, EFRAG believes that a proper
      debate is necessary on fundamental issues related to performance reporting such
      as (a) the notion of performance and the impact of business models on it, (b) the
      content of performance statement(s) and (c) recycling.

47    Finally, as part of this debate, EFRAG believes that measurement at fair value with
      changes in fair value recognised in OCI, subject to an impairment test, should be
      applied to the equity investments that the entity does not intend to sell in the short
      term. The impairment test could be based on the lower of cost or fair value, with
      reversal of losses. Reclassification to profit or loss upon realisation of gains and
      losses resulting from subsequent measurement should be maintained, until an in-
      depth debate has taken place on: (i) performance reporting, (ii) the use of other
      comprehensive income and (iii) reclassification from other comprehensive income
      to profit or loss. Differentiating the impact in profit or loss of changes in value of
      equity instruments, whether they are held-for-trading or for accretion in value,
      would in our view bring useful information to users.




Question 16
The proposed guidance would require an entity to decide whether to measure a financial
instrument at fair value with all changes in fair value recognized in net income, at fair
value with qualifying changes in fair value recognized in other comprehensive income,
or at amortized cost (for certain financial liabilities) at initial recognition. The proposed
guidance would prohibit an entity from subsequently changing that decision. Do you
agree that reclassifications should be prohibited? If not, in which circumstances do you
believe that reclassifications should be permitted or required? Why?




                                          Page 16
        FASB Exposure Draft on Financial Instruments – Draft Comment Letter


Notes for EFRAG’s constituents

48   As explained in paragraph BC105 of the FASB Exposure Draft, the FASB decided
     not to allow an entity the option to reclassify instruments between categories
     because:

           “The Board is concerned that if reclassifications were allowed, entities may
           measure financial instruments that they initially elected to measure at fair
           value with qualifying changes in fair value recognized in other
           comprehensive income at fair value with all changes in fair value recognized
           in net income to recognize gains in net income on appreciated financial
           assets for which an entity is not recognizing losses. The Board believes that
           if reclassifications are allowed, an entity may manage earnings by selling
           winners and holding loser. In addition, because the Board took a top-down
           approach to management’s intentions for classification purposes, the Board
           believes that presenting realized gains and losses separately on the
           performance statement would be sufficient for users to evaluate
           management’s financial instrument activities”.

49   IFRS 9 requires that, if the entity’s business model for managing a financial asset
     changes, that asset should be reclassified.

Response to Question 16

50   EFRAG disagrees with the proposal not to permit reclassification of financial
     instruments when this reflects a real change in the business model of an entity. If
     measurement is based on the business model under which a financial instrument
     is used, then if after initial measurement essential changes in the business model
     occur, such changes should be reflected in the financial reporting and the financial
     instrument should be reclassified accordingly.

51   The FASB states that its proposal not to allow reclassification would prevent some
     forms of earnings management. We are not convinced by this statement and
     believe that this proposal would reduce the relevance of the financial information.
     In particular, continuing to require classification of financial instruments based on
     historical facts and circumstances that have subsequently changed, would not
     result in decision-useful financial reporting.



SUBSEQUENT MEASUREMENT
Question 17
The proposed guidance would require an entity to measure its core deposit liabilities at
the present value of the average core deposit amount discounted at the difference
between the alternative funds rate and the all-in-cost to-service rate over the implied
maturity of the deposits. Do you believe that this remeasurement approach is
appropriate? If not, why? Do you believe that the remeasurement amount should be
disclosed in the notes to the financial statements rather than presented on the face of
the financial statements? Why or why not?




                                        Page 17
           FASB Exposure Draft on Financial Instruments – Draft Comment Letter


Notes for EFRAG’s constituents

52   The response below addresses questions 17.

53   The proposed guidance is addressed in paragraphs 95-96, IG22-IG24, BC123 and
     BC248 of the Exposure Draft.

54   The proposals require core deposits to be measured at the present value of the
     average core deposit balances discounted over the average estimated life at a
     rate equal to the difference between the cost of next alternative available source of
     funding and the cost of providing services to the deposit holders.

Response to Question 17

55   EFRAG believes that the proposed measurement approach for core deposit
     liabilities is not appropriate. We agree with the alternative views expressed in
     paragraph BC248 of the FASB Exposure Draft, specifically that:

     (a)     the introduction of a special new measurement attribute that only applies to
             core deposit liabilities introduces unnecessary complexity;

     (b)     the proposals would result in the measure of a core deposit which reflects
             the cost of alternative funding, i.e. an opportunity cost. This measure is
             purely hypothetical and not representative of the actual benefit attributable to
             the lower cost of funding provided by a core deposit base. In fact, before
             providing such volumes of alternative funding, any third party would assess
             creditworthiness of the financial institution and the continuity of a stable core
             deposit base would play a key role in a positive outcome of this assessment.
             The measure therefore does not reflect reality and is not useful information.

     (c)     the intent of the proposed guidance is to address the accounting for financial
             instruments, not intangible assets. EFRAG believes that it is not appropriate
             to address the measurement of core deposit intangibles in isolation. For
             example, why should core deposit intangibles be measured differently from a
             customer intangible related to a credit card portfolio? We consider that
             guidance on accounting for internally generated intangible assets, including
             core deposits, would be better dealt with as a separate standard that
             develops relevant principles that are applied consistently.

56   In addition, we note the following:

     (a)     if the unit of account is the individual deposit then it would appear that a
             withdrawal by customers would give rise to a loss. If the unit of account is
             the portfolio of core deposits then we would like to understand why the
             portfolio level is preferable and how such portfolios are defined;

     (b)     the re-measurement model described in the FASB Exposure Draft for core
             deposits would significantly rely on non-observable inputs, thus introducing
             additional subjectivity in financial reporting.

57   Given that EFRAG does not believe that the proposed approach for the re-
     measurement of core deposits is appropriate, it follows that we do not think these
     amounts should be reported on the face of the financial statements or in the



                                           Page 18
           FASB Exposure Draft on Financial Instruments – Draft Comment Letter


     accompanying notes. Again, we agree with the alternative views on this topic and
     believe that deposits are best reported in the statement of financial position at the
     amount withdrawable on demand.


Question 18
Do you agree that a financial liability should be permitted to be measured at amortized
cost if it meets the criteria for recognizing qualifying changes in fair value in other
comprehensive income and if measuring the liability at fair value would create or
exacerbate a measurement attribute mismatch? If not, why?

Notes for EFRAG’s constituents

58   The FASB is proposing that a financial liability may be carried at amortised cost if:

     (a)     The liability meets the criteria for the measurement at fair value with changes
             in fair value recognised in other comprehensive income; and

     (b)     Measurement at fair value would create or exacerbate a measurement
             attribute mismatch between recognised assets and liabilities;

     (c)     This option is irrevocably made at the issuance of the financial liability.

59   IASB tentatively has decided to retain existing guidance for financial liabilities
     except for financial liabilities measured at fair value under the fair value option.
     IFRS currently measures most financial liabilities (including core deposit liabilities)
     at amortised cost if they are not held-for-trading.

60   The proposed guidance would provide an amortised cost option for qualifying
     financial liabilities, while IFRS provides a fair value option for qualifying financial
     liabilities.

61   As explained in paragraphs BC117-BC122 of the FASB Exposure Draft, the
     amortised cost option for financial liabilities was introduced to address many of the
     concerns raised about the volatility introduced in income from an asset-liability
     mismatch, for entities other than financial institutions, arising from measuring
     financial liabilities at fair value when significant nonfinancial assets are not
     measured at fair value. For the FASB Exposure Draft, a mismatch exists if:

     (a)     the financial liability is contractually linked to an asset not measured at fair
             value (a financial liability that is collateralised by an asset, or is contractually
             required to be settled upon the derecognition of an asset, is contractually
             linked to that respective asset); or

     (b)     the financial liability is issued by and recorded in, or evaluated by the chief
             operating decision maker as part of an operating segment for which less
             than 50 percent of the segment’s recognised assets are subsequently
             measured at fair value; or

     (c)     the financial liability meets neither item (a) nor (b) but is the liability of a
             consolidated entity for which less than 50 percent of consolidated recognised
             assets are subsequently measured at fair value.


                                            Page 19
           FASB Exposure Draft on Financial Instruments – Draft Comment Letter


     However, the FASB notes that measurement attribute mismatches cannot be
     entirely avoided unless all assets and liabilities are recognised at fair value
     (including intangible assets that are currently unrecognised).

62   It is worth noting that in paragraph BC249 of the Exposure Draft, two alternative
     views are reported: “Ms. Seidman and Mr. Smith believe the amortized cost
     exception provided in the proposed guidance for some financial liabilities lacks an
     underlying concept, is rules based in nature, and would not be operational. They
     fear it would become an albatross for the Board, requiring interpretation and
     causing compliance issues in practice. They would rather have a clear principle
     behind the classification of liabilities that is primarily driven by the variability of
     cash flows and the business model of the entity”.

Response to Question 18

63   As per our responses to questions 13, 15 and 23 and to questions 14 and 22,
     EFRAG strongly supports a mixed measurement approach, based on the business
     model and the characteristics of the financial instruments.

64   We consider that financial liabilities, except for derivatives and financial liabilities
     held-for-trading, should be subsequently measured at amortised cost because this
     measurement better reflects the nature and use of those liabilities. In our view,
     financial liabilities that are not derivatives or held-for-trading, are generally issued
     for funding purposes and paid at maturity. Amortised cost is a more appropriate
     reflection of the payment of contractual cash flows than short-term fair value
     fluctuations, which in our view are not necessarily relevant to users or
     management.

65   EFRAG acknowledges that any mixed measurement model will lead in some
     cases to accounting mismatches as a result of differences in accounting treatment
     between financial instruments and between financial instruments and non-financial
     items. Amortised cost is generally the measurement attribute that best represents
     the business model adopted for financial liabilities and in order to reduce
     accounting mismatches, an option should exist allowing for the adoption of a
     consistent measurement basis for financial assets and financial liabilities, in order
     to better reflect the links existing between those assets and liabilities.

66   In addition, we observe that the FASB is proposing that the amortised cost option
     for liabilities is made irrevocably at initial recognition. This proposal, prohibiting
     any subsequent reclassification, ignores current facts and circumstances and
     could easily lead to financial information that is internally inconsistent with the
     criteria used at initial recognition. Finally, EFRAG is doubtful about the proposed
     50 per cent test for qualifying for measurement at amortised cost, since we do not
     believe that such a ‘bright line’ test would necessarily provide meaningful results.

67   In conclusion, EFRAG supports:

     (a)     the measurement at amortised cost of financial liabilities that are neither
             derivative instruments nor those held-for-trading;

     (b)     the separation of embedded derivatives of hybrid financial liabilities and the
             requirement to account for such embedded derivatives at fair value through
             profit and loss;


                                          Page 20
           FASB Exposure Draft on Financial Instruments – Draft Comment Letter


     (c)     the presence of an option allowing for the adoption of a consistent
             measurement basis for financial assets and financial liabilities, if a consistent
             measurement better reflects the links existing between those assets and
             liabilities.



Questions for users
Question 24
The proposed guidance would provide amortized cost and fair value information on the
face of the financial statements. The Board believes that this would increase the
likelihood that both measures are available to users of public entity financial statements
on a timely basis and that both measures are given equal attention by preparers and
auditors. Do you believe that this approach will provide decision-useful information? If
yes, how will the information provided be used in the analysis of an entity? If not, would
you recommend another approach (for example, supplemental fair value financial
statements in the notes to the financial statements or dual financial statements)?

Question 35
For financial instruments measured at fair value with qualifying changes in fair value
recognized in other comprehensive income, do you believe that the presentation of
amortized cost, the allowance for credit losses (for financial assets), the amount needed
to reconcile amortized cost less the allowance for credit losses to fair value, and fair
value on the face of the statement of financial position will provide decision-useful
information? If yes, how will the information provided be used in your analysis of an
entity? If not, why?

Notes for EFRAG’s constituents

68   The response below addresses questions 24 and 35.

69   The proposed guidance is addressed in paragraphs 86 and BC157-BC158 of the
     FASB Exposure Draft. The main argument in favour of this approach is
     summarised in paragraph BC157 as follows: “The Board believes that this would
     enable an entity to preserve the information available to users today, while also
     providing additional relevant information about the fair value of those instruments.”

Response to Questions 24 and 35

70   EFRAG does not agree with the proposal to present two different measurement
     attributes for the same financial instruments on the face of the statement of
     financial position. We believe that only one measurement attribute should be
     reflected in the primary financial statements for a given financial instrument and
     that this measurement attribute should be either amortised cost or fair value,
     depending on the business model and the characteristics of the instrument.

71   Requiring to present both amortised cost and fair value on the face of the
     statement of financial position for financial instruments held for collection or
     payment of contractual cash flows would result in a confusing representation,
     since:




                                           Page 21
            FASB Exposure Draft on Financial Instruments – Draft Comment Letter


      (a)     amortised cost is the measurement attribute that best represents the
              business model for these instruments;

      (b)     fair value measurement is not relevant since it presents gains that might
              never be realised and losses that are not expected to occur;

      (c)     presenting the fair value implicitly assumes an exit value and such
              information is not useful in assessing the financial performance of an entity
              that does not intend to exit or liquidate its financial assets and liabilities; and

      (d)     for the same financial instrument an entity can only have one business
              strategy to be represented in the financial reporting.

72    In addition, as already explained in our response to Questions 14 and 22, many
      debt instruments held for the collections or payments of contractual cash flows are
      not marketable. The requirement to measure such financial instruments at fair
      value in the statement of financial position would result in increased use of
      reported amounts based on non-observable variables, greater subjectivity and
      reduced comparability among entities.

73    EFRAG is also concerned about the level of detail required on the face of the
      primary statements and the additional complexity introduced by this proposal. We
      believe that the requirement may result in over-detailed primary statements, which
      can obscure key messages and could complicate rather than improve the
      communication between preparers and users of financial statements.

74    We consider that for clarity and relevance reasons, additional information, if and
      when appropriate, is better presented in the notes to the financial statements.


Question 25
For hybrid financial instruments that currently would require bifurcation and separate
accounting under Subtopic 815-15, do you agree that recognizing the entire change in
fair value in net income results in more decision useful information than requiring the
embedded derivative to be bifurcated and accounted for separately from the host
contract? If yes, how will the information provided be used in the analysis of an entity?
If not, for which types of hybrid financial instruments do you believe that it is more
decision useful to account for the embedded derivative separately from the host
contract? Why?

Question 26
IFRS 9 requires hybrid financial assets to be classified in their entirety on the basis of
the overall classification approach for financial assets with specific guidance for applying
the classification approach to investments in contractually linked instruments that create
concentrations of credit risk. Also, for hybrid financial liabilities, the IASB, in order to
address the effects of changes in the credit risk of a liability, tentatively has decided to
retain existing guidance that requires embedded derivatives to be bifurcated and
accounted for separately from a host liability contract if particular conditions are met. Do
you believe that the proposed guidance for hybrid financial instruments or the IASB’s
model for accounting for financial hybrid contracts will provide more decision-useful
information? Why?



                                            Page 22
              FASB Exposure Draft on Financial Instruments – Draft Comment Letter


Notes for EFRAG’s constituents

75      The response below addresses questions 25 and 26.

76      The FASB Exposure Draft retains the existing US GAAP guidance5 for
        identification of embedded derivatives and requires hybrid financial instruments,
        that would otherwise have been required to be bifurcated under existing guidance,
        to be classified and measured in their entirety at fair value with changes in fair
        value recognised in profit or loss. Similarly, IFRS 9 has eliminated the separate
        accounting of embedded derivatives for financial assets, while the IASB tentatively
        decided to retain IAS 39 guidance for bifurcation of hybrid financial liabilities.

77      US GAAP and IAS 39 guidance for identification of embedded derivatives is
        broadly similar and provides for a separate accounting of embedded derivatives
        that present economic characteristics and risks not closely related to those of the
        host contract, although differences between the two standards may arise in
        practice in the determination of whether an embedded derivative is closely related.

78      The FASB Exposure Draft is proposing the following characteristics for
        identification of non-hybrid financial instruments eligible for amortised cost
        measurement6:

        (a)     debt instrument with a principal amount returned at maturity;

        (b)     no prepayment is contractually set such that the holder would not recover
                substantially all of the initial investment;

        (c)     business model of the entity is to hold the financial instrument for collection
                or payment of contractual cash flows.

79      With the due process for the IASB Exposure Draft, Fair Value Option for Financial
        Liabilities, the IASB will complete the classification and measurement phase of the
        IAS 39 replacement project. Based on the IASB Exposure Draft Fair Value Option
        for Financial Liabilities and the requirements of IFRS 9, the requirement for
        classification and measurement of financial assets and financial liabilities will be
        different.

Response to Questions 25 and 26

80      We observe that the following main views have been expressed by constituents in
        commenting on the proposals leading to IFRS 9:

        (a)     except for the issue of own credit risk, there is not a need to change the IAS
                39 requirements for financial liabilities; concerns raised by the IAS 39
                classification and measurement requirements arose, in fact, mainly on the
                asset side and the IASB has addressed them in IFRS 9;




5
    Subtopic 815-15
6
 For such financial instruments the FASB Exposure Draft allows to recognise changes in fair
value in other comprehensive income.


                                             Page 23
           FASB Exposure Draft on Financial Instruments – Draft Comment Letter


     (b)     applying different classification and measurement principles to assets and
             liabilities and different accounting criteria for derivatives that are embedded
             in the same contractual type of host, depending on whether they are assets
             or liabilities, would result in increasing complexity, lack of comparability and
             accounting mismatches (although the latter could be eliminated by applying
             the fair value option);

     (c)     the existing requirements for bifurcation, which are based substantially on
             the same principle under US GAAP and have been retained by the FASB
             Exposure Draft for identification of embedded derivatives, are rules-based
             and difficult to apply.

81   From its own outreach activities, EFRAG understands that constituents express
     the following main views in favour of retaining separate accounting of embedded
     derivatives for assets:

     (a)     Separate accounting has the advantage of reflecting in the financial reporting
             how hybrid instruments are treated by the entity for risk management
             purposes; and

     (b)     Separate accounting is a means of ensuring that, where instruments have a
             significant debt component, this component would be accounted for at
             amortised cost, provided that amortised cost would better represent the
             business model adopted for such instruments.

82   EFRAG would welcome joint efforts of the FASB and the IASB for the
     development of converged requirements leading to the identification of embedded
     derivatives and the classification of financial instruments. The aim of these efforts
     should be to improve the classification criteria and achieve a simple, symmetrical
     and principle-based approach to the bifurcation of embedded derivatives. We
     summarise below the directions that, in EFRAG’s view, the joint effort of the two
     Boards should take.

     (a)     The principle defining the boundaries between amortised cost and fair value
             measurement should more closely reflect the business model adopted for
             the different contractual cash flows present in a financial instrument, giving
             great emphasis to the business model. We acknowledge, however, that the
             characteristics of the instrument must also be considered. For example, it is
             worth considering whether a difference in the nature of cash flows bundled in
             one contract and in a business model applied to those cash flows would
             justify identification of a unit of account at a different level than the entire
             contract.
                                                                                                 Formatted: Outline numbered + Level: 2 +
     (b)     In the definition of the boundaries between amortised cost and fair value with      Numbering Style: a, b, c, … + Start at: 1 +
                                                                                                 Alignment: Left + Aligned at: 0.39" + Tab
             reference to credit risk features related to financial assets held for collection   after: 0.79" + Indent at: 0.79"
             of contractual cash flows, consideration should be given to the amortised
             cost measurement resulting from the application of a forward looking
             approach to expected losses. This approach, unlike the incurred loss
             approach for amortised cost, would allow an entity to properly reflect credit
             risk in the adjustments to expected cash flows, without introducing additional
             variables under fair value measurement, such as liquidity premiums and
             other adjustments. Provided that amortised cost best represents the
             business model adopted by the entity for a financial instrument, this would


                                           Page 24
         FASB Exposure Draft on Financial Instruments – Draft Comment Letter


            allow a broader adoption of the amortised cost measurement compared to
            the requirements of IFRS 9.                                                         Formatted: Font: Not Bold




Question for EFRAG Constituents
Would you support IASB’s efforts by the IASB in the directions specified in
paragraphs 80-82 aboveabove? If so, do you have any specific proposal to make?




Questions for all respondents
Question 27
Do you believe that measuring certain short-term receivables and payables at amortized
cost (plus or minus any fair value hedging adjustments) will provide decision-useful
information? If yes, how will the information provided be used in your analysis of an
entity? If not, why?

Response to Question 27


83    When applying the objective of the amortised cost model to short-term trade
      receivables, attention should be given to the relevance of the resultant information
      compared to a cost measurement. In particular, requiring that an entity provides
      information about the ‘effective return of a financial asset’ assumes that the entity
      holds a financial asset for the purposes of earning revenue from it; this may be
      generally the case for financial institutions. For other entities, whose primary
      assets are short-term trade receivables, the notion of effective return has less
      relevance, since providing deferred payment is part of selling their product. Such
      trade receivables are not held to generate interest revenue and eventual related
      impairment costs are seen as a business expense. For these reasons, entities
      should consider the relevance of the information resulting from the application of
      the effective return to short-term trade receivables.


Questions for all respondents
Question 32
For financial liabilities measured at fair value with all changes in fair value recognized in
net income, do you agree that separate presentation of changes in an entity’s credit
standing (excluding changes in the price of credit) is appropriate, or do you believe that
it is more appropriate to recognize the changes in an entity’s credit standing (with or
without changes in the price of credit) in other comprehensive income, which would be
consistent with the IASB’s tentative decisions on financial liabilities measured at fair
value under the fair value option? Why?




                                          Page 25
            FASB Exposure Draft on Financial Instruments – Draft Comment Letter


Question 33
Appendix B describes two possible methods for determining the change in fair value of a
financial liability attributable to a change in the entity’s credit standing (excluding the
changes in the price of credit). What are the strengths and weaknesses of each
method? Would it be appropriate to use either method as long as it was done
consistently, or would it be better to use Method 2 for all entities given that some entities
are not rated? Alternatively, are there better methods for determining the change in fair
value attributable to a change in the entity’s credit standing, excluding the price of
credit? If so, please explain why those methods would better measure that change.

Question 34
The methods described in Appendix B for determining the change in fair value of a
financial liability attributable to a change in an entity’s credit standing (excluding the
changes in the price of credit) assume that the entity would look to the cost of debt of
other entities in its industry to estimate the change in credit standing, excluding the
change in the price of credit. Is it appropriate to look to other entities within an entity’s
industry, or should some other index, such as all entities in the market of a similar size
or all entities in the industry of a similar size, be used? If so, please explain why another
index would better measure the change in the price of credit.

Question 36
Do you believe that separately presenting in the performance statement significant
changes in the fair value of financial liabilities for changes in an entity’s credit standing
(excluding the changes in the price of credit) will provide decision-useful information? If
yes, how will the information provided influence your analysis of the entity? If not, why?
Do you believe that changes in the price of credit also should be included in this
amount? If so, why?

Response to Questions 32, 33, 34 and 36

84    As we stated in our response to Question 18, in our view:

      (a)     amortised cost should be used in general as the measurement attribute for
              financial liabilities that are neither derivatives nor held-for-trading;

      (b)     embedded derivatives of hybrid financial liabilities should be separated from
              the host contract and accounted for at fair value through profit or loss;

      (c)     there should be an option that allows for consistent measurement and
              recognition for financial assets and financial liabilities, in order to best reflect
              the links existing between those assets and liabilities.

85    EFRAG believes that, when financial liabilities are measured at fair value in order
      to reduce accounting mismatches, fair value changes due to changes in an entity’s
      own credit risk should not be recognised in profit or loss. We think that the
      ultimate test of what is the appropriate accounting treatment is whether the
      approach provides users with the most useful information. Users tell us that
      reporting changes in own-credit is not useful information; indeed, if the effects of
      changes in own credit risk are reflected in the subsequent measurement of
      liabilities, users will generally adjust the financial statements to remove those
      effects if the amounts are material.


                                             Page 26
           FASB Exposure Draft on Financial Instruments – Draft Comment Letter


86   In addition, we consider that it is counter-intuitive, potentially misleading and
     confusing to recognise gains from the deterioration of an entity’s financial situation.

87   In our view changes in fair value attributable to changes in the entity’s own credit
     risk should be gross of changes in the price of credit, for the following reasons:

     (a)     we have concerns about the relevance of the amount that results from
             isolating the entity’s specific credit spread. In fact, we understand that when
             concerns were raised on the misleading representation of profits resulting
             from deterioration in the credit quality of an entity, reference was made to
             changes in the overall credit spread applied to the entity’s debt;

     (b)     separating the two components (changes of price of credit and changes in
             the entity’s specific credit spread) introduces additional complexity, relies on
             non-observable inputs and requires significant management judgement. For
             example, in recent market turbulences, credit spreads often reflect the
             market perception of a systemic risk rather than entity specific elements,
             making more difficult to isolate the entity specific elements;

88   With reference to the methodology applied to measure the changes in fair value
     attributable to changes in the entity’s own credit risk, we believe that an entity
     should be allowed to adopt methodologies that provide a faithful representation.
     The FASB should not prescribe the use of a single predefined methodology.

CREDIT IMPAIRMENT

Notes for EFRAG’s constituents

89   The FASB’s proposed impairment model differs from both the incurred loss model
     (as per IAS 39) and expected loss model as proposed by the IASB in its Exposure
     Draft Financial Instruments: Amortised Cost and Impairment:

     (a)     unlike an incurred loss model, an entity does not wait until a credit loss is
             probable to recognise a credit impairment. Instead, it assesses at the
             financial reporting date the amount of cash flows expected to be collected for
             its financial assets, compared to the contractual amounts due (or, for
             purchased financial assets, the amount originally expected);

     (b)     unlike an expected loss model, an entity considers all available information
             relating to past events and existing conditions, but assumes that existing
             conditions would remain unchanged for the remaining life of the asset,
             without forecasting future events that do not exist at the reporting date.
             Instead, the IASB Exposure Draft on impairment proposes an expected loss
             approach that would require an entity to estimate credit losses on the basis
             of probability-weighted possible outcomes;

     (c)     unlike the IASB’s expected loss model, all credit impairments would be
             recognised in the period in which they are estimated and initially expected
             credit losses would not be recognised at a constant rate over the life of the
             financial asset on the basis of expectations upon origination or acquisition.




                                          Page 27
        FASB Exposure Draft on Financial Instruments – Draft Comment Letter


90   EFRAG recently expressed its view on the same topic, in the 29 June 2010
     Comment Letter on the Exposure Draft Financial Instruments: Amortised Cost and
     Impairment, the views expressed here reflect our comments to the IASB.


Question 37
Do you believe that the objective of the credit impairment model in this proposed Update
is clear? If not, what objective would you propose and why?

Question 38
The proposed guidance would require an entity to recognize a credit impairment
immediately in net income when the entity does not expect to collect all contractual
amounts due for originated financial asset(s) and all amounts originally expected to be
collected for purchased financial asset(s). The IASB Exposure Draft, Financial
Instruments Amortised Cost and Impairment (Exposure Draft on impairment), would
require an entity to forecast credit losses upon acquisition and allocate a portion of the
initially expected credit losses to each reporting period as a reduction in interest income
by using the effective interest rate method. Thus, initially expected credit losses would
be recorded over the life of the financial asset as a reduction in interest income. If an
entity revises its estimate of cash flows, the entity would adjust the carrying amount
(amortized cost) of the financial asset and immediately recognize the amount of the
adjustment in net income as an impairment gain or loss. Do you believe that an entity
should immediately recognize a credit impairment in net income when an entity does not
expect to collect all contractual amounts due for originated financial asset(s) and all
amounts originally expected to be collected for purchased financial asset(s) as proposed
in this Update, or do you believe that an entity should recognize initially expected credit
losses over the life of the financial instrument as a reduction in interest income, as
proposed in the IASB Exposure Draft on impairment?

Notes for EFRAG’s constituents

91   The FASB states the following objective for impairment in the FASB Exposure
     Draft

           “the objective of the guidance related to credit impairment is to establish a
           model for recognition and measurement of credit impairment of financial
           assets measured at fair value with qualifying changes in fair value
           recognized in other comprehensive income on the basis of an entity’s
           expectations about the collectability of cash flows, including the
           determination of cash flows not expected to be collected. An entity’s
           expectations about collectability of cash flows shall include all available
           information relating to past events and existing conditions but shall not
           consider potential future events beyond the reporting date.”

92   As explained in paragraphs BC42 and BC43 of the IASB’s Exposure Draft
     Financial Instruments: Amortised Cost and Impairment: “impairment is an integral
     part of amortised cost measurement”. “Overall, because the proposed impairment
     approach is based on expected credit losses, the proposals would result in an
     expected cash flow approach to amortised cost measurement”.




                                         Page 28
        FASB Exposure Draft on Financial Instruments – Draft Comment Letter


93   The application of the impairment model proposed by the FASB will be restricted
     upon election by the entity to certain short-term receivables measured in the
     statement of financial position at amortised cost and to debt instruments that are
     held for collection of contractual cash flows for which the entity elects to apply fair
     value in the statement of financial position (with changes in fair value recognised
     in other comprehensive income). In contrast, under the IASB proposals the
     expected cash flow approach to amortised cost represents the required approach
     for effective return recognition and statement of financial position measurement for
     financial instruments held for collection or payment of contractual cash flows.

Response to Questions 37 and 38

94   We expressed our detailed views on amortised cost, impairment and interest
     recognition in EFRAG’s Comment Letter to the IASB Exposure Draft, Financial
     Instruments: Amortised Cost and impairment, issued on 29 June 2010. We make
     reference to the details of our position as presented in that letter and summarise
     below our key observations.

95   We support the directions of the IASB impairment model, in preference to the
     FASB impairment model.

96   However, we believe that IASB and FASB models are not directly comparable.
     The FASB’s objective is to establish a model for recognition and measurement of
     credit impairment of financial assets measured at fair value with qualifying
     changes in fair value recognised in other comprehensive income. Given that the
     fair value of financial assets will be the primary basis for reporting the entity’s
     financial position, the FASB’s impairment model is primarily focused on the
     allocation of impairment losses from other comprehensive income to profit or loss.

97   A key element of the FASB’s proposals is that it does not differentiate between
     initially expected credit losses and changes in estimates of cash flows (relating to
     credit) over the life of the financial asset. Under the proposals in the exposure
     draft, an entity recognises a credit impairment immediately in profit or loss when
     the entity does not expect to collect all contractual amounts for originated financial
     assets and all amounts originally expected to be collected for purchased financial
     assets. This approach differs from the IASB’s proposals on credit impairment
     which differentiates between credit losses expected on initial recognition and
     subsequent changes in estimated cash flow relating to future credit losses.

98   In EFRAG’s view, this means that under the FASB’s proposals, a change in
     expectations about the collectability of cash flows due to credit impairment will
     impact profit or loss in the period of that estimate. This would be the case even on
     initial recognition.

99   EFRAG does not agree that credit losses should be recognised on initial
     recognition when the entity believes that it will not recover all the contractual cash
     flows (or initially expected cash flows for purchased assets).

100 EFRAG is supportive of a credit impairment model that is based on estimates of
    expected cash flows (both principal and interest) that eliminates the need for an
    incurred loss trigger, including the elimination of a ‘probability threshold.’
    Additionally, we believe that forward-looking information on credit losses should be
    considered when estimating the collectability of cash flows of financial assets.


                                         Page 29
           FASB Exposure Draft on Financial Instruments – Draft Comment Letter


     We think this is decision-useful because it enables entities to reflect, on a timely
     basis, a greater range of information about the credit quality of financial assets in
     the financial statements.

101 We support the general principles of the IASB’s proposal of a revenue recognition
    model that reflects the initial assessment of credit risk, thus allocating initially
    expected credit losses over the life of the asset, for the following reasons:

     (a)     the resulting pattern of interest income reduced by initially expected credit
             losses provides useful information about the effective return on a financial
             asset. The resulting delay in interest revenue recognition resulting from the
             spread of initial expected credit losses reflects that some of the interest
             revenue is paid in compensation for future expected credit losses.

     (b)     The resulting revenue recognition would improve consistency between
             pricing (or purchase consideration) on initial recognition (with credit risk
             reflected implicitly or explicitly in an instrument’s contractual interest rate)
             and its ongoing measurement. It also addresses the systematic
             overstatement of revenue under the incurred loss model in the periods
             before credit losses were incurred.

102 Unlike the IASB proposal to recognise the effects of changes in estimate in the
    period of re-estimate, EFRAG believes that gains and losses, resulting from
    subsequent changes in the estimate of future credit losses for a forward looking
    approach to impairment, should be recognised in the period of the re-estimate, to
    the extent that the change relates to current or prior periods. We believe that
    changes in estimates of future cash flows should not be recognised immediately in
    profit or loss, since they relate partially to future periods.


Question 39
Do you agree that credit impairment should not result from a decline in cash flows
expected to be collected due to changes in foreign exchange rates, changes in expected
prepayments, or changes in a variable interest rate? If not, why?

Notes for EFRAG’s constituents

103 The FASB Exposure Draft proposes that changes in cash flows expected to be
    collected that relate to changes in foreign exchange rates, changes in expected
    prepayments, or changes in a variable interest rate shall not in and of themselves
    give rise to a credit impairment. For financial assets with contractual interest rates
    that vary on the basis of subsequent changes in an index or rate estimates of cash
    flows expected to be collected in future periods shall be recalculated at each
    reporting date on the basis of the index or rate as it changes over the life of the
    financial asset. An entity shall not project changes in the index or rate for
    purposes of estimating cash flows expected to be collected.                  In some
    circumstances, it may be difficult to isolate the effect of a change in one specific
    component from the overall change in cash flows. When changes in expected
    cash flows due to variable rates or prepayments cannot be separated from the
    overall decline in expected cash flows, an entity shall account for the entire decline
    in cash flows expected to be collected as a credit impairment.



                                          Page 30
           FASB Exposure Draft on Financial Instruments – Draft Comment Letter


104 In its response to the IASB, Request for Information (‘Expected Loss Model’)
    Impairment of Financial Assets: Expected Cash Flow Approach, EFRAG
    expressed the following view on Impairment of Variable Rate Instruments:

     “When a financial instrument becomes impaired, future interest cash flows are in
     effect treated as repayments of principal rather than interest revenue. Under the
     Expected Loss Model there are two possible approaches to treating this
     ‘repayment of principal’ to variable rate instruments:

     (a)     Approach A: Recalculate the effective interest rate (based on the forward
             curve as updated from time to time) so that the still-expected future interest
             and principal receipts are discounted to the carrying amount; or

     (b)     Approach B: Keep the effective interest rate constant after impairment and
             treat changes in the carrying amount resulting from changes in variable
             benchmark interest rate as a ‘catch-up’, reflecting the fact that changes in
             cash flows more appropriately reflect repayments of principal rather than
             variable interest receipts.”

     EFRAG supported Approach A, since Approach A recalculates the effective
     interest so that the still expected future interest receipts and the still expected
     principal receipts are discounted to the carrying amount. However, EFRAG also
     noted that, although a similar recalculation occurs under the current incurred loss
     model, these will increase in regularity and range of application across instruments
     under the Expected Loss Model and that will probably mean that Approach A is
     the more complex and costly of the two approaches for preparers to implement.

Response to Question 39

105 We believe that changes in estimates of cash flows due to prepayments, foreign
    exchange rates and changes in interest rates should be in general excluded from
    an assessment of ‘credit impairment,’ as far as they do not trigger any credit
    impairment. For example, considering a loan denominated in foreign currency,
    gains and losses from translation into the entity’s functional currency should be
    excluded from impairment, but if the change in foreign exchange rate is such that
    the capacity of the borrower to fulfil its obligation is affected, this circumstance
    should result in credit impairment.

106 Credit impairment shown separately from other changes in expected cash flows
    provides useful information about the quality of a financial asset and the debtor’s
    ability to perform under contractual terms. Value changes such as those resulting
    from foreign exchange, changes in interest rates and prepayments are due to the
    existing contractual terms and are therefore different in nature to credit
    impairments and should be shown separately.

107 When and how changes in expected cash flows arising from changes in
    expectations of prepayments, foreign exchange and interest rates impact profit or
    loss, depends heavily on the measurement model adopted for the underlying
    asset. For financial assets held at amortised cost (per the IASB model), EFRAG
    believes that the reported measure of the financial asset should reflect any kind of
    revision for the expected cash flows, including, where appropriate, a change in the
    prepayment level compared to what was initially estimated, changes in foreign
    exchange and variable interest rates. However, we consider it important to


                                          Page 31
        FASB Exposure Draft on Financial Instruments – Draft Comment Letter


     differentiate between changes in estimates that relate to changes in the credit
     quality of the asset (i.e. the ability of the debtor to perform its obligations) and
     other changes in value. Therefore, we support the IASB’s proposals to separately
     present gains and losses as a result of changes in estimates of future credit losses
     from changes in cash flows resulting from other factors (e.g. prepayments). We
     believe that changes in exchange rates should not result in impairment but in
     foreign exchange gain or losses that should be recognised in accordance with the
     relevant standard.

108 In addition, changes in variable interest rates should not result in impairments or
    adjustments to the carrying amount of floating rate financial assets measured at
    amortised cost.

CREDIT IMPAIRMENT AND INTEREST INCOME RECOGNITION


Question 41
Do you agree that if an entity subsequently expects to collect more cash flows than
originally expected to be collected for a purchased financial asset, the entity should
recognize no immediate gain in net income but should adjust the effective interest rate
so that the additional cash flows are recognized as an increase in interest income over
the remaining life of the financial asset? If not, why?

Question 48
The proposed guidance would require interest income to be calculated for financial
assets measured at fair value with qualifying changes in fair value recognized in other
comprehensive income by applying the effective interest rate to the amortized cost
balance net of any allowance for credit losses. Do you believe that the recognition of
interest income should be affected by the recognition or reversal of credit impairments?
If not, why?

Question 53
The method of recognizing interest income will result in the allowance for credit
impairments presented in the statement of financial position not equalling cumulative
credit impairments recognized in net income because a portion of the allowance will
reflect the excess of the amount of interest contractually due over interest income
recognized. Do you believe that this is understandable and will provide decision-useful
information? If yes, how will the information provided be used? If not, why?




                                        Page 32
         FASB Exposure Draft on Financial Instruments – Draft Comment Letter


Question 54
The proposed guidance would require interest income to be calculated for financial
assets measured at fair value with qualifying changes in fair value recognized in other
comprehensive income by applying the effective interest rate to the amortized cost
balance net of any allowance for credit losses. Thus, the recognition of a credit loss
would result in a decrease in interest income recognized. Similarly, a reversal of a
previously recognized credit loss would increase the amount of interest income
recognized. The IASB Exposure Draft on Impairment proposes that an entity calculate
interest by multiplying the effective rate established at initial recognition by the amortized
cost basis. The IASB’s definition of amortized cost basis is the present value of
expected future cash flows discounted by the effective interest rate established at initial
recognition and, therefore, includes credit losses recognized to date. Thus, as initially
expected credit losses are allocated over the life of the instrument, the amount of
interest income decreases. Both the FASB’s and the IASB’s models for interest income
recognition are similar in that the recognition of an impairment reduces the amount of
interest income recognized. However, as noted in the questions above, the timing of
credit impairments and the determination of the effective interest rate differ in the two
proposed models. Thus, the amount of interest income recognized under the two
proposed models will differ. Do you believe that the FASB’s model or the IASB’s model
provides more decision-useful information? Why?

Question 55
Do you agree that an entity should cease accruing interest on a financial asset
measured at fair value with qualifying changes in fair value recognized in other
comprehensive income if the entity’s expectations about cash flows expected to be
collected indicate that the overall yield on the financial asset will be negative? If not,
why?

Notes for EFRAG’s constituents

Accounting for changes in cash flow estimates

109 The FASB Exposure Draft requires that, after the initial recognition of impairment
    in profit or loss, a subsequent impairment (or reversal of credit impairment) is
    measured and recognised in profit or loss based on changes in the present value
    of cash flows expected to be collected, compared to the previous estimate. The
    discount factor to be used for this exercise is the effective interest rate as
    measured at the date of origination or acquisition.

110 The above accounting treatment would apply to all the circumstances, except for
    purchased assets acquired at an amount that included a discount related to credit
    quality. For such assets, if the reassessment indicates an improvement in
    expected cash flows compared to the cash flows initially expected, the entity
    recalculates the effective interest rate based on revised expected cash flows and
    discounts the expected cash flows at the revised effective interest rate on a
    prospective basis.

Interest income recognition

111 For financial assets measured at fair value, with qualifying changes in fair value
    recognised in other comprehensive income, the FASB proposes that an amount of


                                          Page 33
              FASB Exposure Draft on Financial Instruments – Draft Comment Letter


        interest income should be recognised in profit or loss. This amount shall be
        determined by applying the financial asset’s initial effective interest rate to the
        amortised cost balance, net of any allowance for credit losses. The FASB
        believes that this requirement would be successful in avoiding the recognition of
        interest income on the principal that is not expected to be collected. The
        requirement would remove a feature of the existing accounting treatment that, in
        the FASB’s view, has contributed to the reporting of higher interest income in the
        earlier years on lower credit quality financial assets, even though an entity expects
        to have losses in the future on some portion of those assets.

112 The FASB Exposure Draft requires that the difference between the amount of
    interest contractually due and the amount of interest receivable, accrued on the
    basis of the above accounting treatment, is recognised as an increase in the
    allowance for credit losses. If, as a result of this requirement, the cumulative
    allowance for credit losses would exceed the entity’s estimate of future cash flows
    not expected to be collected, a reversal of impairment expense is recognised in
    profit or loss. This requirement would also result in cumulative credit impairments
    recognised in profit or losses not equalling the cumulative allowance for credit
    losses.

113 The FASB Exposure Draft requires7 an entity to cease accruing interest income for
    a financial asset only if the expectations about cash flows expected to be collected
    indicate that the overall yield on the financial asset will be negative, that is the total
    cash flows expected to be collected are less than the original cash outflow for the
    financial asset.

Response to Questions 41, 48, 53, 54 and 55

114 The response below addresses questions 41, 48, 53, 54 and 55.

115 In their effort to develop a converged proposal on accounting for financial
    instruments, we would encourage the FASB to work with the IASB with a particular
    focus on impairment and interest income recognition. This is in fact a key
    component of a converged approach for financial instruments. The aim of the joint
    effort of the two Boards should be to ensure global comparability of book values
    and interest recognition, resulting from the application of the amortised cost
    measurement.

116 We agree with the IASB’s proposals that initially expected credit losses should be
    allocated over the life of the financial asset. Nevertheless, EFRAG is concerned
    with the use of the effective interest rate for the allocation of initially expected
    credit losses over the life of the financial asset. In particular:

        (a)     estimating the timing and amount of initially expected credit losses is very
                difficult at the individual financial asset level and generally becomes more
                reliable at the portfolio level;

        (b)     contractual interest and credit risk are generally managed separately. We
                understand from constituents that these factors may make the allocation of



7
    Paragraph 82 of the FASB Exposure Draft.


                                               Page 34
           FASB Exposure Draft on Financial Instruments – Draft Comment Letter


             initially expected credit losses estimated at the portfolio level, using the
             effective interest estimated at the individual asset (or for closed portfolio
             level) impractical;

     (c)     allocation of the initially expected credit losses using the effective interest
             rate can be operationally burdensome. We would be supportive of
             approaches that approximate the allocation profile achieved by the proposals
             in the IASB Exposure Draft Financial Instruments: Amortised Cost and
             Impairment, but which ‘decouple’ the effective interest rate calculation from
             the allocation of initially expected losses;

     (d)     As highlighted by the IASB’s Expert Advisory Panel, operational difficulties
             arise because financial institutions and others typically store comprehensive
             contractual and accounting data (in particular effective interest rate data) and
             expected losses data information in separate systems (‘accounting’ and ‘risk’
             systems).

Accounting for changes in cash flow estimates

117 With reference to accounting for changes in estimates, EFRAG disagrees with
    both the FASB and IASB proposals to recognise the effects of changes in
    estimates in profit or loss in the period of re-estimate. Instead, EFRAG is
    supportive of an impairment model that:

     (a)     provides for recognition of changes in estimated future cash flows in those
             future periods, rather than in the period of the re-estimate. In this way,
             changes in estimates would be reflected in such a manner that the carrying
             amount of the financial asset represents credit losses that relate to periods
             up until the reporting date;

     (b)     provides for allocation of changes in expected future cash flows over the
             remaining life of the financial asset, to the extent that the net interest margin
             is sufficient to absorb that allocation;

     (c)     provides that, if the change in estimate allocation is not compensated by the
             future net interest margin (i.e. it is, in effect, onerous), the non-compensated
             portion of the gain or loss is recognised in the period of the re-estimate. As
             a result, the statement of financial position would represent a current
             assessment of future cash flows based on current and future credit
             conditions.

118 EFRAG acknowledges that in the context of an expected credit losses model (i.e.
    requiring to spread initially expected credit losses over the life of the financial
    asset), it would also be possible to recognise a gain without having recognised a
    loss in profit or loss, as a result of a change in estimate in the past. EFRAG would
    support a neutral model, requiring the treatment of favourable and adverse
    changes in expected cash flows to be symmetrical. For example, spreading the
    effect of favourable changes in estimates, whilst recognising adverse changes in
    profit or loss, immediately would result in a biased model.

Interest income recognition




                                           Page 35
            FASB Exposure Draft on Financial Instruments – Draft Comment Letter


119 Since the interest margin (before credit losses) is a key indicator for users of
    financial statements of financial institutions, EFRAG is supportive of an effective
    return approach to amortised cost and interest income recognition that would
    provide the allocation of initially expected credit losses over the life of the financial
    asset, while requiring a separate allocation of both interest revenue (fees, points
    received, transaction costs and other premiums and discounts) and initially
    expected credit losses.

120 We disagree with the approach proposed by the FASB for interest income
    recognition, i.e. requiring the application of the effective interest rate (excluding
    credit losses) to the amortised cost less cumulative credit allowance, for the
    following reasons:

      (a)     we believe that this approach would result in bringing subjectivity (due to the
              measurement of credit allowance) into the reported interest income for
              financial assets;

      (b)     we have concerns about the relevance of a credit allowance that does not
              reflect the amount of net cumulative impairments accounted for in profit and
              loss;

      (c)     the proposed approach would result in mixing the effects of interest
              recognition with reversals of impairment losses.

121 EFRAG would support a method for interest income recognition that would
    separately identify interest revenues (i.e. fees, points received, transaction costs
    and other premiums and discounts) from credit losses, also for financial assets
    with a negative yield (i.e. with cumulative past and expected cash inflows lower
    than initial outflow). We are concerned about the introduction of specific
    recognition rules to be applied only in certain circumstances.

Questions for users
Question 43
The credit impairment model in this proposed Update would remove the probable
threshold. Thus, an entity would no longer wait until a credit loss is probable to
recognize a credit impairment. An entity would be required to recognize a credit
impairment immediately in net income when an entity does not expect to collect all of the
contractual cash flows (or, for purchased financial assets, the amount originally
expected). This will result in credit impairments being recognized earlier than they are
under existing U.S. GAAP. Do you believe that removing the probable threshold so that
credit impairments are recognized earlier provides more decision-useful information?




                                           Page 36
           FASB Exposure Draft on Financial Instruments – Draft Comment Letter


Question 44
The proposed guidance would require that in determining whether a credit impairment
exists, an entity consider all available information relating to past events and existing
conditions and their implications for the collectibility of the cash flows attributable to the
financial asset(s) at the date of the financial statements. An entity would assume that
the economic conditions existing at the end of the reporting period would remain
unchanged for the remaining life of the financial asset(s) and would not forecast future
events or economic conditions that did not exist at the reporting date. In contrast, the
IASB Exposure Draft on impairment proposes an expected loss approach and would
require an entity to estimate credit losses on the basis of probability-weighted possible
outcomes. Do you agree that an entity should assume that economic conditions existing
at the reporting date would remain unchanged in determining whether a credit
impairment exists, or do you believe that an expected loss approach that would include
forecasting future events or economic conditions that did not exist at the end of the
reporting period would provide more decision-useful information?

Questions for preparers and auditors
Question 46
 [...] Do you agree that an entity should assume that economic conditions existing at the
reporting date would remain unchanged in determining whether a credit impairment
exists, or do you believe that an expected loss approach that would include forecasting
future events or economic conditions that did not exist at the end of the reporting period
would be more appropriate? Are both methods operational? If not, why?

Notes for EFRAGs constituents

122 The FASB Exposure Draft requires that an entity assesses at the financial
    reporting date the amount of cash flows expected to be collected for its financial
    assets, compared with the contractual amounts due for originated financial
    asset(s) and all amounts originally expected to be collected upon acquisition of
    purchased financial asset(s). An entity should not wait until a credit loss is
    probable to recognise a credit impairment.

123 The FASB decided8 that the impairment model should not be based on a notion of
    incurred losses and a credit loss need not be deemed probable of occurring to
    recognise a credit impairment. The FASB explains that removing the probability
    threshold would result in an entity recognising credit impairments in profit or loss
    earlier, on the basis of its expectations about the collectability of cash flows rather
    than on a potentially arbitrary recognition threshold.

124      “The expected loss approach to impairment for financial assets eliminates the
        requirement for a ‘trigger event’ thus enabling entities to use a broader range of
        credit-related forward looking information and, where appropriate, recognise
        impairment losses on financial assets earlier.”




8
    As explained in paragraph BC174 of the FASB Exposure Draft.


                                            Page 37
        FASB Exposure Draft on Financial Instruments – Draft Comment Letter


125 It should be noted that, as reported in paragraph BC175 of the Exposure Draft, the
    FASB believes that the proposed approach does not represent an ‘Expected loss
    approach’:

           “Under an expected loss approach, an entity would forecast expected cash
           flows over the life of a financial asset or pool of financial assets and would
           recognize credit impairment of its financial assets in net income on the basis
           of those expectations. The Board believes the model in the proposed
           guidance is different from an expected loss model because it would require
           an entity to consider the effects of past events and existing conditions in
           estimating the cash flows it expects to collect in future periods that make up
           the remaining life of its financial assets, but it would not permit an entity to
           forecast future events or economic conditions in developing those estimates
           as would occur in an expected loss model. In addition, the Board
           understands that the timing of recognition of credit impairments under an
           expected loss model would differ from the timing of recognition of credit
           impairments under the model in the proposed guidance. Under an expected
           loss model, the Board understands that an entity would recognize a constant
           rate of credit impairments through the life of the financial asset based on
           expectations about losses on the date of acquisition or origination, with any
           changes from initial expected credit impairments recognized in the period of
           the change. With respect to the timing of recognition, under the model in the
           proposed guidance, all credit impairments would be recognized in the period
           in which they are estimated, rather than being allocated and recognized at a
           constant rate over the life of the financial asset on the basis of expectations
           upon origination or acquisition. The Board decided not to pursue an
           expected loss model because the Board believes that oftentimes it would be
           difficult for an entity to accurately forecast expected cash flows through the
           life a financial asset on the basis of forecasted future events. The Board
           also believes that it would be inappropriate to allocate an impairment loss
           over the life of a financial asset”.

Response to Questions 43, 44 and 46

126 The incurred loss model for credit impairment has been criticised and the need to
    identify a trigger event for impairment recognition has been seen as a factor
    contributing to the late recognition of credit losses in the recent global financial
    crisis. EFRAG supports the development of an alternative to the incurred loss
    impairment model for financial assets that uses more forward-looking information
    about credit losses and aims to eliminate the delay in recognition of credit losses.
    In particular, EFRAG agrees that the probability threshold for the recognition of an
    impairment loss should be eliminated, allowing in this way earlier recognition of
    impairments.

127 EFRAG is supportive of an expected loss approach for measuring impairment and
    agrees that expected cash flows used for measuring the financial assets at
    amortised cost should reflect not only past and existing conditions but all the
    existing information about expected future developments. EFRAG supports the
    inclusion of forecasts for future events or economic conditions as a way for
    reflecting more forward-looking information in the measurement of credit losses for
    financial assets. We think this would result in more relevant information, because
    it enables entities to reflect, on a timely basis, a greater range of information about
    the credit quality of financial assets in their reported measurement.


                                         Page 38
        FASB Exposure Draft on Financial Instruments – Draft Comment Letter


128 In addition, we consider that requiring an entity to isolate credit information that
    relates to past and existing trends, from that which relates to forecasts of future
    developments, adds complexity and judgement to the estimation process that
    could result in reduced comparability.


Question 50
The proposed guidance would permit, but would not require, separate presentation of
interest income on the statement of comprehensive income for financial assets
measured at fair value with all changes in fair value recognized in net income. If an
entity chooses to present separately interest income for those financial assets, the
proposed guidance does not specify a particular method for determining the amount of
interest income to be recognized on the face of the statement of comprehensive income.
Do you believe that the interest income recognition guidance should be the same for all
financial assets?

Interest Income – Questions for users
Question 52
Do you believe that the method for recognizing interest income on financial assets
measured at fair value with qualifying changes in fair value recognized in other
comprehensive income will provide decision-useful information? If yes, how will the
information provided be used in your analysis of an entity? If not, why?

Response to Questions 50 and 52

129 As mentioned in the response to Questions 41, 48, 53, 54 and 55, EFRAG would
    support a method for interest income recognition that would separately identify
    interest revenues (i.e. fees, points received, transaction costs and other premiums
    and discounts) from credit impairment losses.

130 Given the importance that the interest margin has for users, particularly for those
    interested in financial institutions, we believe that a consistent methodology for
    interest recognition should apply to all financial instruments, regardless of the
    classification in fair value through profit or loss or amortised cost measurement
    categories.

131 We do not support the proposal to require a separate presentation of interest
    income or expenses for financial instruments measured at fair value through profit
    or loss, since we believe that changes in fair value capture all the relevant
    information for financial instruments held-for-trading purposes.



HEDGE ACCOUNTING

Questions for all respondents
Question 56
Do you believe that modifying the effectiveness threshold from highly effective to
reasonably effective is appropriate? Why or why not?



                                        Page 39
           FASB Exposure Draft on Financial Instruments – Draft Comment Letter


Notes for EFRAG’s constituents

132 The FASB Exposure Draft9 contains the following guidance on hedge
    effectiveness: “The qualifying criteria for designating a hedging relationship
    requires that the hedging relationship, at its inception and on an ongoing basis, is
    expected to be reasonably effective (rather than highly effective) in achieving
    offsetting changes in fair values or cash flows attributable to the hedged risk
    during the period of the hedging relationship. The risk management objective
    expected to be achieved by the hedging relationship and how the hedging
    instrument is expected to manage the risk or risks inherent in the hedged item or
    forecasted transaction shall be documented. For most relationships, compliance
    with the reasonably effective criterion is demonstrated by a qualitative (rather than
    quantitative) assessment that establishes that an economic relationship exists
    between the hedging instrument and either the hedged item in a fair value hedge
    or the hedged transaction in a cash flow hedge. A quantitative assessment is
    necessary if a qualitative assessment cannot establish compliance with the
    reasonably effective criterion.”

Response to Question 56

133 EFRAG supports the objective of simplifying hedge accounting in a way that
    appropriately reflects how risk is managed by an entity.

134 EFRAG recognises that the overall classification and measurement framework for
    financial instruments set out in the FASB Exposure Draft is fundamentally different
    from that in the IASB proposals and therefore the application of the hedge
    accounting provisions would be different.

135 Nevertheless, EFRAG is supportive of a simplification of existing guidance for
    hedge effectiveness and for the removal of a quantitative assessment of hedge
    effectiveness. EFRAG therefore supports the adoption of qualitative criteria to
    assess effectiveness, as this would help reduce complexity in applying the hedge
    accounting rules.


Question 57
Should no effectiveness evaluation be required under any circumstances after inception
of a hedging relationship if it was determined at inception that the hedging relationship
was expected to be reasonably effective over the expected hedge term? Why or why
not?

Question 58
Do you believe that requiring an effectiveness evaluation after inception only if
circumstances suggest that the hedging relationship may no longer be reasonably
effective would result in a reduction in the number of times hedging relationships would
be discontinued? Why or why not?




9
    Paragraph 113 of the FASB Exposure Draft


                                           Page 40
         FASB Exposure Draft on Financial Instruments – Draft Comment Letter


Notes for EFRAG’s constituents

136 Paragraph 117 of the Exposure Draft proposes that, after inception of the hedging
    relationship, an entity reassesses effectiveness qualitatively (or quantitatively, if
    necessary), only if changes in circumstances suggest that the hedging relationship
    is no longer reasonably effective. As explained in paragraph BC218 of the
    Exposure Draft;

            “to provide for further simplification, the Board decided that, after inception of
            the hedging relationship, an entity would need to qualitatively (or
            quantitatively, if necessary) reassess effectiveness only if changes in
            circumstances suggest that the hedging relationship may no longer be
            reasonably effective. Thus, the need for reassessing effectiveness at least
            quarterly would be eliminated unless changes in circumstances suggest that
            a hedging relationship may no longer be reasonably effective. The Board
            believes that the costs of compliance would be reduced because an entity
            would not have to develop sophisticated quantitative statistical models to
            prove a hedging relationship is effective in situations in which it is obvious
            that a hedging relationship is effective. Users of financial statements also
            would be served by not having to deal with on-again, off-again hedge
            accounting for the same derivative and hedged item.”

Response to Questions 57 and 58

137 As explained above, EFRAG would encourage a simplification of the existing
    requirements for hedge accounting that reflects an entity’s risk management
    activities.

138 Nevertheless, we are not convinced that the FASB’s proposals would result in
    substantial simplification. In fact, although the effectiveness test would be
    performed only at inception and only in certain circumstances thereafter, the
    requirements to recognise the impact of ineffectiveness in net income would still
    be applicable. As a result, at each reporting date an entity would need to measure
    (i) the changes in fair value of the derivative, (ii) the changes in the fair value of the
    hedged item attributable to the hedged risk and (iii) the ineffectiveness that
    occurred in the period.

139 In addition, should this proposal be adopted, detailed implementation guidance
    would be needed to identify appropriately those circumstances that evidence
    ineffectiveness, in order to ensure comparability between entities.



Hedge Accounting – Questions for users
Question 59
Do you believe that a hedge accounting model that recognizes in net income changes in
the fair value and changes in the cash flows of the risk being hedged along with
changes in fair value of the hedging instrument provides decision-useful information? If
yes, how would that information be used? If not, why?




                                          Page 41
           FASB Exposure Draft on Financial Instruments – Draft Comment Letter


Notes for EFRAG’s constituents

140 Under current guidance, paragraph 89 of IAS 39 requires for fair value hedges
    that:

     (a)     gain or losses from re-measuring the hedging instrument at fair value shall
             be recognised in profit or loss;

     (b)     gain or losses on the hedged item attributable to the hedged risk shall adjust
             the carrying amount of the hedged item and be recognised in profit or loss.

141 Under current guidance, paragraphs 95 and 96 of IAS 39 require for cash flow
    hedges that:

     (a)     the portion of the gain or loss on the hedging instrument that is determined
             to be an effective hedge shall be recognised in other comprehensive income;
             and

     (b)     the ineffective portion of the gain or loss on the hedging instrument shall be
             recognised in profit or loss. In particular, only ineffectiveness due to the
             derivative’s change in fair value being greater than the change in the hedge
             item’s fair value (i.e. overhedging) is recognised immediately in profit or loss.

142 The requirements presented in the two paragraphs above are similar to existing
    US GAAP. In particular, as explained in paragraph BC225 of the Exposure Draft,
    “Topic 815 requires ineffectiveness to be recognized in net income only when the
    cumulative change in fair value of the actual derivative exceeds the cumulative
    change in fair value of the hypothetical derivative (referred to as an overhedge). ...
    The basis for conclusions in Statement 133 states that the reason for not
    recognizing ineffectiveness on underhedges is that only ineffectiveness due to
    excess expected cash flows on the derivative should be reflected in net income,
    because otherwise a nonexistent gain or loss on the derivative would be deferred
    in other comprehensive income and recognized in net income.”

143 As explained in paragraphs BC226 to BC228 of the Exposure Draft,

             “The proposed guidance would require that measurement of hedge
             ineffectiveness be based on a comparison of the change in fair value of the
             actual derivative designated as the hedging instrument and the present
             value of the cumulative change in expected future cash flows of the hedged
             transaction. For example, that could be accomplished by comparing the
             change in fair value of the actual derivative and the change in fair value of a
             derivative that would mature on the date of the forecasted transaction and
             that would provide cash flows that would exactly offset the hedged cash
             flows. ... The primary objective of cash flow hedge accounting is to manage
             the timing of recognition in income of the gains and losses on a derivative
             instrument used to lock in or fix the price of a future transaction. ... However,
             locking in or fixing the price of the future transaction would occur only if an
             entity entered into a derivative that would mature on the date of the
             forecasted transaction and that would provide cash flows that would exactly
             offset the hedged cash flows. ... The Board believes that ineffectiveness
             should be recognized in net income if an entity enters into a derivative that
             would not mature on the date of the forecasted transaction and provide cash


                                           Page 42
        FASB Exposure Draft on Financial Instruments – Draft Comment Letter


           flows that would exactly offset the hedged cash flows (that is, not locking in
           or fixing the price). ... The Board believes that it is preferable to treat
           overhedges and underhedges consistently.”

Response to Question 59

144 EFRAG accepts that requiring a symmetrical recognition of ineffectiveness, arising
    from the cumulative changes in fair value from the hedged item being either higher
    or lower than cumulative changes in fair value from the hedging
    derivativeinstrument, would result could be seen as a simplification of in a
    symmetrical accounting treatment for cash flow hedges. that is less complex.

145 Nevertheless, EFRAG does not agree with the proposed requirement and believes
    that, in a cash flows hedge, ineffectiveness due to cumulative changes in fair value
    of the hedged transaction item being in excess of those from the hedging
    derivative instrument (i.e. underhedging) should not be recognised. Requiring that
    underhedging is not recognised as this avoids recognition of gains and losses on
    transactions that do not yet exist (i.e., highly probable forecast transactions).

146 HoweverSimilarly, this should not apply if cumulative changes in the fair value of
    the hedged transaction are greater than those of the derivative hedging instrument      Formatted: Font: Italic
    because the entity is designating only a portion of the cash flows of the hedged        Formatted: Font: Italic
    transaction as a for the hedged item, one should not treat the unhedged part of a       Formatted: Font: Italic
    transaction as an underhedge accounting. In this circumstance, in fact, the excess
                                                                                            Formatted: Font: Italic
    of changes in fair value from the hedged transaction over those of the derivative
    does not represent ineffectiveness. It rather reflects a portion of cash flows that
    are not designated for hedging purposes and should be recognised.




                                        Page 43
       FASB Exposure Draft on Financial Instruments – Draft Comment Letter



APPENDIX 2



Comment letters issued by EFRAG on accounting for financial instruments



EFRAG Comment Letter on the IASB Exposure Draft, Fair Value Option for Financial
Liabilities, issued on 17 July 2010



EFRAG Comment Letter on the IASB Exposure Draft, Financial Instruments: Amortised
Cost and Impairment, issued on 29 June 2010



EFRAG Comment Letter on the IASB Exposure Draft, Financial Instruments:
Classification and Measurement, issued on 21 September 2009



EFRAG Comment Letter on the IASB Discussion Paper, Reducing Complexity in
Reporting Financial Instruments, issued on 30 September 2008




                                    Page 44

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:0
posted:9/28/2012
language:English
pages:44